What's in Focus for 2007 Beyond MiFID and the Exchanges

MiFID has been a key focus for many months now,given both the tactical and strategic impact it will have on the buy and sell-side,and market microstructure in particular. There is no doubt the MiFID themes play largely in our plans,but they are not the only things in focus for Goldman Sachs in 2007.

There are several key things, some related to the changes being
driven by MiFID and the Exchanges, which should be front of mind
for both the buy and sell side. We would categorise these into
three areas:

Liquidity
Aggregation and Smart Access

Execution
Quality

Multi-Asset
Trading

Liquidity Aggregation and Smart Access

Post MiFID, we
anticipate that there will be further migration of liquidity to
electronic trading venues, and a proliferation in the number and
type of venues available for Pan-European shares trading. This is
due not only to the removal of concentration rules post MiFID and
the fact that firms will be able to create new Pan European
liquidity venues as alternatives to the existing regulated
markets, but is also due to technological innovation and
micro-structure changes themselves.

Fragmentation
is not new to the European market. Given the high level of OTC
trading, often for larger block trades, that takes place
primarily between and among the buy and sell side and market
makers, we estimate that in some markets, up to 50% of the volume
is already traded off the order books of the main domestic
exchanges.

OTC liquidity
can best be defined as anything that is non-displayed, and
consists of unexecuted orders in the systems of brokers and
orders resting on the blotters of buy-side traders. There is also
non-displayed liquidity available at established venues such as
crossing networks and hidden order types on existing exchanges.
Visible liquidity is just a portion of the total liquidity
available at a given point in time.

A fundamental
structural change that is taking place is that many of these
traditional sources of non-displayed liquidity are now becoming
electronically accessible where they previously had not been, and
available to the next generation smart routers and algorithms.

The result
will be an increase in the need for access to these new
electronic liquidity pools via Execution Management Systems (EMS)
and smart order routing to navigate between them.

We have
extended our GS smart order routing technology, SIGMA, in Europe
in preparation for the impending changes. SIGMA enables GS to
electronically and anonymously execute client trades against both
displayed and non-displayed liquidity. As liquidity venues become
available, we will connect to them, providing customers with an
ability to reach any publicly available liquidity pool in an
intelligent and fast manner.

The unique
feature of SIGMA, however, is that in addition to Exchange and GS
liquidity, it routes to previously untapped liquidity sources,
primarily large existing market makers with whom GS has formed
partnerships.

We've made
this service available via our EMS and via FIX interfaces to OMS
systems

Additionally,
we've added a range of next generation algorithms to our GSAT
suite that specialise in accessing these non-traditional pools of
liquidity.

Sonar, for
example, uses an array of order types to seek liquidity in harder
to trade names without ever representing anything on the order
book. Sonar serves as the traders "market eye" by constantly
monitoring multiple liquidity sources and then executing at
optimal levels, meanwhile avoiding market impact given no
representation on the book.

We have also
added our Dynamic Scaling algorithm which provides an intelligent
overlay to a traditional "percentage of volume" (POV) based
strategy. Dynamic Scaling enables clients to actively manage
their participation based on the absolute or relative price of
the name. Clients can make decisions based on a price view, while
at the same time managing market impact.

Lastly, we
have extended our sophisticated implementation shortfall
algorithm to portfolios, Port X, enabling clients to execute a
basket according to a customized execution schedule, which
balances transaction costs against risks in a number of ways."As
liquidity venues become available, we will connect to them,
providing customers with an ability to reach any publicly
available liquidity pool in an intelligent and fast manner."

"As liquidity venues become available, we will connect to them,
providing customers with an ability to reach any publicly
available liquidity pool in an intelligent and fast manner."

A new focus on execution quality - increasing importance of TCA
and Flow Segmentation

In addition to
the focus on electronically accessing liquidity, there is now
more importance being placed on measuring execution quality.

The drivers
for this are many: the increase in unbundling and CSAs which
enables a sole focus on execution performance; MiFID's "best
execution" requirements; and, an increasing focus on costs as a
result of both reduced spreads and the ability to now identify
and track these costs.

Given this
focus, the rationale for the innovations we are bringing to the
market - smart routing tools and next generation algorithms -
seems well understood by the buy-side, but we think it is
important to clearly prove the benefits of using these tools to
clients. As a result, we will be upgrading our Transaction Cost
Analysis (TCA) and post-trade reports to incorporate alternative
liquidity sources.

Sophisticated
and comprehensive transaction cost analysis tools are no longer
"nice to haves" but rather "required features" of any EMS,
trading system or execution provider.

Given the
increasing number of venues, strategies and styles that can be
utilized, clients are often not sure how they should be directing
and monitoring their flow; we advise clients to pursue a "flow
segmentation" approach. Even when using the "flow segmentation
model", given the increase in the number, complexity and pace of
development of execution of options, it is almost impossible for
clients to remain up to speed on the best ways to manage their
flow. To address this, we have experienced trading and sales
trading professionals, located in a separate building from the
"upstairs" desks, that monitor all of the
electronic flow and advise clients based on market conditions
and the client's execution objectives.

We describe
this essential new function as "execution consultancy", as the
professionals provide clients with on-going, pro-active, advice
on why, where and how they should be executing their flow.

Multi-Asset Trading from a Single Platform

We are seeing
changes not only in how clients are trading, but in what they are
trading and where. We are seeing diversification in both asset
classes and markets.

In attempting
to find new ways of gaining exposure to certain names or sectors,
or for hedging large positions, clients are expanding beyond
simple cash Equities into sector products, Futures, options, FX
and Commodities.

It is now
commonplace for us to set-up clients to trade across multiple
asset classes, and in multiple regions. We now have well-over a
hundred REDIPlus® installations that are trading Futures and
Cash Equities on REDIPlus®, and in some cases Options and FX
too. We have also done a considerable amount of work to integrate
the back-end processes to enable true STP for

The "flow
segmentation" approach factors in: size of the order, liquidity
of the name, and urgency with which the trade needs to get done,
and then advises on how to direct the flow based on those
parameters.

As demands
increase on the buy-side trader, this helps seperate the "hard to
trade" from simply flow which could go to an algorithm.

This provides
clients with a broadly applicable framework to help manage all of
their flow.

The "flow
segmentation" approach factors in: size of the order, liquidity
of the name, and urgency with which the trade needs to get
done, and then advises on how to direct the flow based on those
parameters.

As demands
increase on the buy-side trader, this helps seperate the "hard
to trade" from simply flow which could go to an algorithm.

This provides clients with a
broadly applicable framework to help manage all of their flow.

Consolidated risk reporting and post-trade processing.

These are
products that were previously traded separately and often by
different people, but this is changing as the demand for
electronic trading capabilities increases. We think there is a
significant benefit to clients if all the electronic execution
functions can be supported in one platform, both from a trading
system perspective but also from a relationship perspective.

We expect this
multi-asset trend to continue and to see both broker-sponsored
and vendor systems aggressively pursuing these capabilities in
2007.

In addition to
expanding the asset classes, both the buy and sell side are
making a strong push into the emerging markets.

As we know,
many firms are currently focused on establishing their "hi-touch"
presence in markets in the BRICs (Brazil, Russia, India, China)
countries, as well as the other growing Eastern European
countries.

We are seeing
that the push for electronic trading capabilities in these
markets is not lagging far behind. This rapid pace of development
comes as no surprise given the growth expectations for these